Fitch Places KDG on Rating Watch Negative

Tue Mar 18, 2014 11:23am EDT

(The following statement was released by the rating agency) MOSCOW/LONDON, March 18 (Fitch) Fitch Ratings has placed Kabel Deutschland Vertrieb and Service GmbH's (KDG) 'BBB+' Long-term Issuer Default Rating (IDR) on Rating Watch Negative (RWN), in line with the rating action on its parent, Vodafone Group Plc (Vodafone; A-/RWN). A full list of rating actions is at the end of this comment. KDG is an established cable provider in Germany with growing broadband, telephony and premium/pay-TV franchise. Vodafone acquired a majority 76.6% stake in the company in October 2013, and is planning to use it as its core operational platform for wireline development in Germany. KEY RATING DRIVERS Strong Shareholder Support Following its acquisition by Vodafone, Fitch rates KDG using a top-down approach, at a notch lower than the parent's rating. Operating and strategic ties between the two companies are strong. KDG gives Vodafone an opportunity to provide facilities-based wireline services in Germany, which complements its existing alternative fixed-line franchise and strong mobile positions in the country. Following the acquisition, Vodafone issued a EUR2.15bn intercompany loan to KDG, in what Fitch views as evidence of tangible shareholder support. Weak Legal Ties Legal ties between KDG and Vodafone are weak. There are no cross-default provisions in Vodafone's documentation referencing KDG. The parent does not guarantee any of KDG's debt. KDG has not ruled out the option of continuing to source funding from the capital market. Fitch does not view a domination and profit and loss pooling agreement between the two companies as strengthening legal ties as it does not provide protection for KDG creditors. Mid 'BB' Standalone Credit Profile Although the company's standalone operating profile is potentially consistent with a low investment grade rating, this is offset by high leverage, leaving KDG with a standalone credit profile at the mid 'BB' level. The company recently reiterated its leverage target range of between 3.0x and 3.5x net debt/adjusted EBITDA (as per the company's definition). Stable TV Business KDG benefits from a stable basic TV subscriber base that generates almost utility-type revenue. This is enhanced by the company's expansion into the premium/pay-TV segment with a positive impact on average revenue per user. The cable industry's share in TV distribution in Germany has been fairly stable for many years at around 50% and is unlikely to come under significant pressure. Strong Broadband Growth KDG has experienced strong broadband growth in a mature market. The cable industry has accounted for a dominant share in new subscriber additions in Germany since end-2009. A combination of super-fast broadband speeds, not achievable by digital subscriber line peers, and moderate pricing provides a window of opportunity to make inroads into competitors' market shares. Solid Network Infrastructure Where upgraded to the Docsis 3.0 standard on 95% of the network, KDG is currently capable of delivering super-fast commercial speed of 100 megabits per second, turning the company into a strong facilities-based internet broadband provider, ahead of telecoms incumbent in many areas. However, Docsis3.0 upgrades are taking longer than initially projected. The continuing EUR300m accelerated capex programme suggests that certain other infrastructure upgrades are necessary including node splits and 862 MHz technology upgrades. Strong Margins and FCF KDG's EBITDA margin was strong at 47.7% in the 12 months to December 2013 and has been improving, due to its enlarged scale. A planned EUR300m of accelerated capex in 2013-2014 would temporarily put pressure on cash flows, but Fitch estimates that pre-dividend FCF generation should remain positive. Instrument Ratings Fitch rates KDG's secured debt at the same level at its IDR, as we typically do not notch up ratings for security for investment-grade rated issuers. Unsecured creditors at the level of Kabel Deutschland Holding AG, an immediate holding company above KDG, are structurally subordinated to unsecured creditors to KDG and are therefore notched down. RATING SENSITIVITIES The RWN on KDG's ratings is likely to be resolved once the RWN on its parent Vodafone is resolved. Stronger legal ties with Vodafone, such as the parent guaranteeing KDG's debt, could lead to an upgrade of KDG's IDR and selected instrument ratings. Weaker operating and strategic ties with Vodafone could put pressure on the ratings. FULL LIST OF RATING ACTIONS Long-Term IDR: 'BBB+' placed on RWN Senior secured notes due 2018 issued by KDG: 'BBB+' placed on RWN Senior notes due 2017 issued by KDH: 'BBB' placed RWN Contact: Principal Analyst Slava Bunkov Associate Director +7 495 956 9931 Supervisory Analyst Nikolai Lukashevich, CFA Senior Director +7 495 956 9968 Fitch Ratings CIS Ltd 26 Valovaya Street Moscow 115054 Committee Chair Damien Chew, CFA Senior Director +44 20 3530 1424 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. Additional information is available on www.fitchratings.com. For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary. Applicable criteria, 'Corporate Rating Methodology', dated 05 August 2013, are available at www.fitchratings.com. 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